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Sale of S stock by QSST.

In Rev. Rul. 92-84, the Service concluded that gain from the sale of S stock held by a qualified subchapter S trust (QSST) was taxable to the current income beneficiary (CIB), even though the entire proceeds from the sale of the S stock (including the capital gain) were added to the trust corpus and payable to the remainder party on termination of the trust, rather than to the CIB. The CIB was required to report the gain on his individual income tax return and pay the resulting capital gain tax.

Unless the QSST makes provision for discretionary distributions of principal to the CIB, the trustee should seek judicial reformation of the governing instrument in order to permit reimbursement by the trust to the CIB of the capital gain tax paid by the CIB.

A further complication could be posed by Rev. Rul. 77-402, which held that conversion of a subpart E (grantor) trust to a regular trust, on the lapse or surrender of the trust donor's subpart E power, was a taxable disposition of an installment obligation held by the former grantor trust. In most cases, the deferred installment gain is "triggered" by disposition of the obligation.

A similar result could occur with a QSST unless the IRS expands on Rev. Rul. 92-84. The QSST will become a "regular" trust after disposing of the S stock and reinvesting the stock sale proceeds, or holding the installment note to collect principal and interest thereon. In addition, the former QSST could hold an installment note received in liquidation of the S corporation that sold its assets and distributed the buyer's installment note to its former shareholder.

Specifically, the Service should narrow Rev. Rul. 77-402 so that it does not apply to a QSST that is merely a deemed grantor trust and continues as a regular trust after disposing of its S stock. The general rule of Sec. 453B(h) should also apply when the former QSST receives an installment note in liquidation of the S corporation; i.e., installment note reporting should continue for the former QSST as a former stockholder.
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Title Annotation:qualified subchapter S trust
Author:Conley, James B.
Publication:The Tax Adviser
Article Type:Brief Article
Date:Jan 1, 1994
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